Published: October 12, 2011
While the concept of ‘strategic sourcing’ has been in vogue for the past ten years or so, in reality the notion has existed since time immemorial. Obtaining goods of the right quality, delivered in the right place, at the right time and at the right price is sound business practice and while the means of achieving this has become more sophisticated, complex, and geographically diverse, this remains the basis of every procurement strategy. This article looks at some of the ways in which the procurement function has evolved, and the strategic role that it now plays. Furthermore, with an efficient physical and financial supply chain now critical to the business success of every organisation, what are the immediate opportunities and benefits of treasury and procurement working more closely together?
Procurement officers may be variously known as buyers, purchasers or strategic sourcers, but however these professionals are named, the traditional emphasis has been on negotiating with suppliers in order to reduce or avoid costs. With complex products and services, involving components and raw materials around the globe, one product often combines inputs from hundreds of suppliers. Buying from any one of these at the wrong price can mean that the cost of the final product is undercut by a competitor, which could be a disaster for a major product launch. Order the wrong quantity or at the wrong time, and a company could end up with cash locked in a stockpile or unable to meet consumer demand. Net profit is therefore a key metric in procurement.
Order the wrong quantity or at the wrong time, and a company could end up with cash locked in a stockpile or unable to meet consumer demand.
Since the early 1980s, four different conditions have come into place that have allowed an increase in scope for treasury and procurement professionals. Firstly, the implementation of enterprise resource planning solutions (ERP), secondly an overall increase of political freedom, thirdly the liberation of the capital markets and, last but not least, the access to low cost sourcing countries. These four variables have been the basis for the increase in the complexity and strategic importance of the buying process.
As supply lines continue to extend further into new markets, procurement has become increasingly professionalised, with high calibre, highly qualified executives joining procurement departments, who have contributed to the strategic input that procurement makes to the businesses as a whole. The way that procurement fits into the organisational structure can differ as much as business models differ, with Chief Procurement Officers (CPOs) responsible to the CEO, the head of the relevant region, COO, CTO, CFO or even the Chief Marketing Officer; however, what is important is that CPOs today have a critical role to play in achieving a company’s strategic objectives.
As procurement becomes more sophisticated, procurement officers are increasingly becoming responsible for the quality of supplies, specific risk management KPIs, and have a major role in supply chain integration. From a treasurer’s perspective, the activities of procurement are key. The issue of a purchase order, receipt of goods and receipt of an invoice are all vital milestones in the financial supply chain as they directly affect working capital metrics, specifically days payable outstanding (DPO). Consequently, from a treasury perspective, there is a strong incentive to work closely with procurement to understand future payment flows.
However, there are potential friction points. These are primarily the result of having different objectives and metrics for measuring success. For example, payment incentives offered by suppliers, such as early payment discounts, may reduce the cost of goods and services and therefore meet procurement’s objectives. On the other hand, reducing DPO may be detrimental to working capital and liquidity management, and therefore compromise treasury’s goal to maintain adequate levels of liquidity and avoid short term borrowing to cover working capital shortages. Treasury therefore needs to understand and be able to influence procurement decision-making that has a potentially negative impact on the group as a whole. [[[PAGE]]]
The benefits of a co-ordinated approach are not restricted to treasury and procurement however. For a major company with purchasing costs extending into billions of dollars, establishing a closer link between treasury and procurement is increasingly recognised as being an essential element in a cohesive business strategy across the financial supply chain, from sourcing through to sales. A robust financial supply chain relies on stability at each stage, which includes the continuity of key suppliers. Over the past five years the credit crunch has illustrated that if suppliers are unable to deliver on supply contracts, for liquidity or other reasons, then the entire supply chain is at stake, both physically and financially. In the past, many procurement departments considered suppliers as adversaries, and negotiation was seen as a combative activity. Today, this approach is less common, and companies are increasingly recognising their mutual reliance with suppliers, and the need to conduct business affairs in a way that protects both parties’ position.
It is our understanding that there are three immediate opportunities for treasury and procurement departments to increase collaboration and support the strategic direction of their companies. The first one is protecting suppliers’ liquidity position. This is an area in which procurement and treasury can work closely together in the mutual interests of the company, whilst supporting the objectives of both departments. Supplier financing, for example, which is typically managed by treasury, is a valuable way of protecting suppliers’ liquidity position by enabling them to secure timely or early payment whilst enabling the company potentially to extend DPO, with the interim period financed by the bank. This also satisfies procurement’s requirement to secure the best pricing possible from suppliers, as they may be in a better position to offer preferential pricing if they are accessing financing through the company’s programme.
A second opportunity resides in the need to have greater communication and alignment of key performance indicators (KPIs) that are in the best interests of the company as a whole, as opposed to individual departments. This is typically a more significant cultural change than technical integration as discussed below, particularly in companies where procurement is still recognised primarily for cost reductions. However, both finance (including treasury and accounts payable) and procurement have an important contribution to make to DPO which in turn impacts working capital metrics such as the return on capital employed (ROCE) of the company and the economic value added (EVA) of the business’ shareholders. For example, measuring working capital improvement and using this as a KPI represents a major opportunity to work together, particularly with strategic suppliers, and offers tangible benefits.
The third opportunity is another key area of potential collaboration that delivers mutual benefit; the ability to hedge price volatility, such as the cost of commodities. Reducing cost and ensuring the predictability of input costs is a priority for both procurement and treasury, and by understanding procurement’s future commodity requirements, treasury can help to achieve this. There are many situations when procurement still sources commoditised raw materials without reference to treasury, with a potential risk to damaging the business in the short and medium terms.
There are a variety of ways in which procurement and treasury can co-operate more closely. The use of an ERP tool such as SAP and Oracle to manage the supply chain is almost universal amongst most large multinationals and means that different parts of the business share a common view of data, which may be integrated with other specialist systems such as treasury management systems. However, mergers & acquisitions, and decentralised business planning often means that corporations have multiple ERPs or different installations of the same system across the group. During the 1990s, companies increasingly implemented ERP integrated customer relationship management (CRM) systems to support sales activities. These systems have been instrumental in helping companies understand their customer base in more detail.
Treasury needs to understand and be able to influence procurement decision-making that has a potentially negative impact on the group as a whole.
Based on the success of these applications, sourcing platforms are now becoming more popular. The next major step will be to integrate the ERP and sourcing platforms to develop an integrated view of the physical and financial supply chain, and increase the visibility and metrics of procurement flows by treasury. As we’ve seen above, the access to real time information will definitely support the improvement if the outcomes of a treasury-procurement collaboration and the global profitability of the company.
So with considerable opportunity and incentive for procurement and treasury to collaborate more closely, is this yet the reality for most companies? A key factor is the culture of the company and how influential the treasurer and CPO are within the organisation. In large multinationals operating in diverse markets and sophisticated supply chains, procurement and finance (including treasury) are more likely to work closely together. In addition, there is more likely to be finance expertise within the procurement department, so the procurement team are more aware of the time value of money and the impact of their activities on the cost of funding. [[[PAGE]]]
We anticipate that procurement and treasury will become more closely integrated in many more companies, particularly as the profile of the two departments continues to elevate. Procurement is caught between the operational and financial functions within the company, but by aligning the department more closely with both of these, they can bridge the gaps in the physical and financial supply chains and ensure maximum efficiency. The global supply model continues to become more complex which will necessitate further collaboration in order to remain competitive. For example, some goods such as clothing have a very long supply chain with multiple suppliers. While today’s supplier finance programmes support a company’s direct suppliers, these often ignore the large number of small companies further down the supply chain that will often have the most severe liquidity constraints.
Procurement and treasury can often operate from any part of the world, which provides an opportunity to collaborate and integrate purchasing decisions into the financial metrics of a company which should influence supplier negotiation directly, and vice versa. With geographically diverse supply chains, reducing the cost of inputs cannot be considered the sole objective for procurement; after all, while it may be cheaper to source supplies or raw materials in emerging markets, the benefit may be lost if the cost of transport is expensive. By working together, supply chains can be better aligned, properly funded, more cost effective, and with enhanced control over working capital.
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